In: Finance
What are two common measures of stock risk, what do they tell us, and how are they calculated?
Also include in your discussion the Sharpe Ratio.
Two measures of stock risk are standard deviation and Sharpe Ratio
Standard deviation :
Standard deviation = (x - x̅)2 / N
where x = value of observation
x̅ = arithmetic mean of sample
N = number of observations in sample
Standard deviation measures the dispersion around the mean. Higher the standard deviation, more the dispersion of the data around the mean.
In the case of stocks, a stock with higher standard deviation will have higher volatility (higher risk)
Sharpe Ratio :
Sharpe ratio is a measure of the excess return earned per unit of risk
Sharpe ratio = (Rs - Rf) / s,
where Rs = return of stock
Rf = risk free rate
s = standard deviation of stock returns
Sharpe ratio measures the excess returns of the stock above the risk free rate, for each unit of standard deviation